7 Aug 2018
Well, we thought it would never happen: the Bank of England (BoE) actually went through with a 25-basis-point interest rate hike on Thursday.
The second UK rate increase since the financial crisis caused barely a blip in the gilt market. In fact, 10-year yields actually fell slightly as the bank rate moved to 0.75%. The BoE’s decision was unanimous – all nine committee members voted in favour – but another increase isn’t expected for at about 18 months. Bank Governor Mark Carney set out his stall in last week’s press conference. Essentially, the BoE thinks that the potential growth rate for the UK – the sustainable speed of growth that won’t spur inflation – has fallen over the past couple of years. That’s because weak productivity growth continues to dog the nation: the large jump in the measure at the end of last year was followed by a significant fall in the first quarter.
Inflation has cooled from the 3% level of six months ago, but it’s still above the BoE’s 2% target. Economic data have improved recently, which could increase inflationary pressures. Retail sales were much higher this summer than last, broadly PMIs have been ok and construction is much stronger than it was. Unemployment is still very low and the cost of labour has been growing at its highest rate in five years. Putting all this together means the UK may improve its woeful GDP growth in the coming months, but it will simply agitate inflation. The preliminary estimate of UK GDP will be released on Friday, so that will be a helpful gauge of whether Mr Carney’s caution on inflation is warranted. Mr Carney is also worried about Brexit, the likelihood of a no-deal exit and its effect on the economy. This hike puts another rate cut in his pocket in case things go pear-shaped down the road; it’s not exactly a bazooka, but it’s something …
Out East, the Bank of Japan (BoJ) slightly adjusted its quantitative easing programme, but reaffirmed its intention to keep monetary policy very loose for the foreseeable future. The BoJ’s unprecedentedly enormous purchases of bonds and equities have left it holding Japanese government bonds and stock market ETFs almost equal in value to the nation’s entire $4.9tn GDP. This hasn’t managed to get inflation to the 2% the BoJ is aiming for. The 1.5% hit earlier this year has since slipped down to 0.7%.
Source: FE Analytics, data sterling total return to 3 August 2018
The panto president
The US market is a bit like a panto at the moment. Everything on stage is gay and rosy, except for a goblin who keeps popping up with dreary monotony to add a certain nervous tension to the show. With the right kind of ears you can hear the market calling out, “He’s behind you!” as another round of trade threats rolls around the globe.
The S&P 500’s quarterly earnings season is wrapping up and EPS growth is a broad-based 24%, according to FactSet. Much of this has been driven by the cut in taxes, but sales have increased by an average of almost 10%. In aggregate, earnings have been coming in about 5% higher than expected. Consumer discretionary stocks have been particularly exciting (in a good way) – no doubt helped by Amazon delivering more than double EPS estimates – while energy companies have been the most disappointing. This 20%-odd earnings growth is widely expected to continue for the rest of 2018 before slowing in early 2019.
What’s really driving investors is forecasts. Companies that are conservative about their prospects for coming quarters are getting punished by investors. This is not a new phenomenon, but it’s interesting that it continues to linger even in the face of very tidy profits. There’s also been a style shift in the past few weeks. Money has been coming out of technology and other growth companies that have performed very well of late. Some of that appears to have flowed into financials and other cyclicals that should benefit from higher US growth and interest rates.
But then the goblin. President Donald Trump leaned on the bellows again last week. After a couple of weeks of conciliation between China and the US, Mr Trump said he is preparing to hit $200bn of Chinese imports with new levies. China says it would retaliate by imposing tariffs on $60bn of US goods. The bellicose American move came at a point when the world was starting to think maybe the chances of a tit-for-tat trade war were receding. The US and Europe had come to an agreement over trade that avoided tariffs and Mr Trump was beginning to appear more measured.
“He’s behind you!” indeed.